Automatic Indexation of the Pension Age to Life Expectancy: When Policy Design Matters

Abstract

Increasing retirement ages in an automatic or scheduled way with increasing life expectancy at retirement is a popular pension policy response to continuous longevity improvements. The question addressed here is: to what extent is simply adopting this approach likely to fulfill the overall goals of policy? To shed some light on the answer, we examine the policies of four countries that have recently introduced automatic indexation of pension ages to life expectancy–The Netherlands, Denmark, Portugal and Slovakia. To this end, we forecast an alternative period and cohort life expectancy measures using a Bayesian Model Ensemble of heterogeneous stochastic mortality models comprised of parametric models, principal component methods, and smoothing approaches. The approach involves both the selection of the model confidence set and the determination of optimal weights. Model-averaged Bayesian credible prediction intervals are derived accounting for various stochastic process, model, and parameter risks. The results show that: (i) retirement ages are forecasted to increase substantially in the coming decades, particularly if a constant period in retirement is targeted; (ii) retirement age policy outcomes may substantially deviate from the policy goal(s) depending on the design adopted and its implementation; and (iii) the choice of a cohort over period life expectancy measure matters. In addition, the distributional issues arising with the increasing socio-economic gap in life expectancy remain largely unaddressed.

Progressive Pension Formula and Life Expectancy Heterogeneity

“…Second, life expectancy does not take into account the fact that mortality rates fall with time and at varying rates for people in different socioeconomic groups. Recent empirical evidence (Ayuso et al 2021b); (Bravo et al 2021); (Ayuso et al 2021a) show that, at retirement ages, most countries have a significant and systematic divergence in cohort and period life expectancy measures, resulting in significant ex-ante tax/subsidies from generations to come to present generation and, as a result, an unjust actuarial relationship between contributions and pension benefits. In addition, this affects labor supply decisions, resulting in macroeconomic inefficiencies, and wrongly communicates solvency expectations, delaying pension changes.…”

“…Longevity heterogeneity and pension fairness have been studied quantitatively since (Ayuso et al 2017); (Ayuso et al 2021b); (Bravo et al 2021). In order to measure the overall intensity of the transfer mechanism, profiles for tax/subsidy rates are computed from variances in life expectancy.…”

Drawing Down Retirement Financial Savings: A Welfare Analysis using French data

“…3 An alternative approach is to use a Bayesian Model Ensemble (model combinations) of stochastic mortality models [2,6,22,27,35] or continuous-time affine-jump diffusion models [17,30].…”

“…In recent decades, most countries have responded to continuous longevity improvements, population ageing, and low market returns with systemic and/or gradual parametric pension reforms to restore solvency and enhance the fiscal sustainability of public pensions while balancing with pension adequacy concerns. Adopted reforms include modifying the pension system rules and parameters (e.g., the retirement age), increasing pre-funding (reserve funds), enhancing work incentives, modifying pension taxation, expanding contribution options, expanding the coverage of private funded (mandatory or voluntary) pensions, developing auto-enrolment schemes, switching from existing DB schemes to DC schemes, expanding individual accounts in personal, employer, and state pensions and providing greater freedom over how pension pots [1][2][3]27]. The growth of financial and notional individual account systems and longevity developments have increased the importance of studying the decumulation phase of pensions from different perspectives.…”

Intergenerational Actuarial Fairness When Longevity Increases: Amending the Retirement Age

“…Recent empirical studies show that the life expectancy gap at retirement age is sizable, persistent, and still increasing in most countries , which translates into an ex ante unintended financial transfer from future to current generations. Moreover, the adoption of rule-based approaches linking the retirement age to period instead of cohort life expectancy and poor policy design result in policy outcomes that deviate substantially from their initial intentions (Ayuso et al 2021b;Bravo andAyuso 2020, 2021). Since public pension scheme reforms need to be backed by both public approval and democratic support, reforms that are either inter-or intragenerationally unfair are less likely to succeed in balancing the needs and interests of current and future generations and will tend to be rejected by voters, especially if they involve retrenchments.…”